Infrastructure as an asset class is usually seen as a decent hedge against inflation as companies operating within the space tend to generate earnings which rise in line with the price of general goods and services.
While the consensual view was that the extraordinary amounts of central bank intervention – through quantitative easing and ultra-low interest rates – would bring about inflation, western economies seem to have entered a period of disinflation.
Issues such as a significant amount of debt still in the system, a lack of bank lending growth, ageing populations and spare capacity in the economy have all been cited as reasons for this phenomenon, but nevertheless inflation in the UK has fallen to 1.5 per cent while in the eurozone it stands at a worrying 0.3 per cent.
Performance of index in 2014
Source: FE Analytics
Questions have been asked whether investors need to inflation-proof their portfolios in the current environment given that deflation looks like the more immediate threat, but Ellis says that his trust, unlike others in the IT Infrastructure sector, can hold up in either environment.
The major reason for this, according to Ellis, is that while its rivals invest in the equity of infrastructure companies, GCP Infrastructure Investments is the only listed trust which focuses primarily on investments in infrastructure debt.
“We anticipate that the portfolio will be protected in an inflationary environment as around 70 per cent of it has linkage to the retail prices index [RPI]. If RPI were to exceed 3 per cent, we would see the cashflow arising from our portfolio to be boosted.”
“This really isn’t that different to other infrastructure and renewables funds, however, because they also have significant inflation linkage.”
“Where we do differ from the other funds, on the flipside, is that we are protected in a deflationary environment. That is because as we are a fixed rate debt provider, our income would not suffer if RPI were to fall or even go negative.”
Ellis added: “We don’t tend to make any assumptions about future deflation or inflation rates because we are receiving a minimum fixed level of income, which should rise if inflation were to rise.”
Bonds are seen as one of the best hedges against deflation as investors receive a fixed level of income, but in an inflationary environment they are one of the worst asset classes to hold as investors can receive a negative real yield.
The trust is effectively a fixed interest portfolio as it provides debt for long-dated infrastructure projects which have UK governmental support. However, as Ellis explains, the large majority of GCP’s assets are linked to inflation.
“Typically, we try to achieve loan terms along the following lines: Assume a £100 loan for 20 years at 9 per cent; where possible, we require that the loan is indexed on an upwards only basis. This means that, in a year where RPI is 2 per cent, we just get our £100 times 9 per cent interest.”
“However, where RPI is 4 per cent, we increase the nominal value of our loan. Thus at the end of that year our loan has increased in size to £100.50, and the 9 per cent is calculated on that larger size, and we get repaid that larger size when the loan matures.”
“Importantly, whatever RPI does the following year – such as it goes to zero – our loan stays at the higher amount; i.e. it is a ratchet.”
GCP Infrastructure Investments was launched in July 2010. According to FE Analytics, its shares have returned 49.92 per cent, meaning it has outperformed the average trust in the IT Infrastructure sector.
It has also beaten both the FTSE All Share and the iBoxx Sterling Gilts All Maturities index, which have returned 44.48 per cent and 27.82 per cent respectively over that time.
Performance of trust vs sector and indices since July 2010
Source: FE Analytics
It has also had a lower maximum drawdown, which measures how much an investor would lose if they bought and sold at the worst possible time, than both equities and bonds over that time at just 4.21 per cent.
However, while the trust has performed well, it has also traded on a premium to its NAV. Like the large majority of trusts in the sector, it is currently trading on a wide 9.37 per cent discount.
Source: FE Analytics
The current valuations caused F&C’s Peter Hewitt to tell FE Trustnet that investors are locking in losses if they buy into infrastructure investment trusts now as their lofty premiums will only fall as interest rates rise over the coming year.
However, Oriel Securities’ Iain Scouller doesn’t agree with this view. Scouller agrees that GCP Infrastructure Investments is a decent option for investors who want to protect their portfolios against both inflation and deflation.
He also says investors shouldn’t necessarily be put off buying infrastructure trusts at their current prices as there is a huge amount of demand for their high yields and the low volatility of their returns.
In terms of GCP in particular, he thinks it should remain on a premium for some time to come and therefore has the trust as a ‘hold’.
“The portfolio is valued regularly by Mazars, taking into account industry developments and the fund publishes a monthly NAV. If the discount rate was reduced by 25bps at the 31 December 2014 valuation point, this would increase the NAV by 1.8 per cent.”
“The last NAV was 104.5p (cum-div) and 102.6p (ex-div) at 30 September 2014 and this would imply an NAV of 103.5p to 105.5p (ex-div) and 105.4p to 107.4p (cum-div) at 31 December 2014.”
“Given the high yield, we think the shares should trade on a premium to NAV and our fair value is increased to 114p – previously 110p.”
“The fair value is based on a 5 per cent premium to the estimated NAV of 105.4p to 107.4 at 31 December 2014, plus two quarterly estimated dividends of 1.9p each for the next six months. The dividend yield is attractive at 6.5 per cent, the highest yielding fund in the sector.”
GCP Infrastructure Investments concentrates on private finance initiatives and renewable energy. Projects in both sectors tend to be based on 25 to 30-year contracts, RPI linked and are government backed.
The trust isn’t geared and has ongoing charges of 1.5 per cent.
